Getting to bottom of Ponzi schemes and how they work

What do disgraced Montreal investment adviser Lino Matteo and Wall St. baron Bernard Madoff have in common?

Both are among a growing number of businessmen recently accused of running so-called Ponzi schemes.

The former chief executive officer of Mount Real Corp. and the ex-chairman of the Nasdaq Stock Market have been charged with defrauding investors of $130 million and $50 billion respectively using the same method.

We asked the Canadian Anti-Fraud Call Centre, better known as PhoneBusters, to explain how the scam works.

Q: So the scheme is actually named after a real person?

A: Carlo “Charles” Ponzi, who operated under several aliases, was an Italian immigrant to the United States who arrived in 1903 with reportedly only $2.50 in his pocket after having gambled away the rest of his life savings during the voyage. Four years later, he moved to Montreal and became an assistant teller in the newly opened Banco Zarossi. He ended up spending three years in a Quebec prison for forging the signature of bank director on a $423.58 cheque to himself. Ponzi returned to the U.S. after his release in 1911 and set up in Boston. It was from there where he would become one of the greatest swindlers in American history.

Q. What is a Ponzi scheme?

A. A Ponzi scheme is one which returns investor’s funds not from earnings, but from the principal contributed by subsequent investors. No legitimate investment exists and the money from later investors is used to pay off earlier obligations providing an appearance of legitimacy. It is also known as a pyramid scheme. In Ponzi’s case, he became involved in buying and selling international postal reply coupons from Italy that could be exchanged for U.S. postage stamps with a higher value. He got friends and associates to back his scheme, offering them a 50 per cent return on investment in 45 days, and started his own firm, the Securities Exchange Company, to promote the scheme.

Q. Are there ways to avoid being caught in a Ponzi scheme?

A. We offer some helpful tips.

• Beware of “loading” plans that ask you to buy costly inventory.

• Beware of claims that you will make money by recruiting new members rather than by sales you make yourself.

• Beward of promises about high profits or claims about “miracle” products.

• Beware of “shills” – people paid by the operator to make grandiose claims about the success of the plan.

• Refuse to make a financial commitment or sign a contract in a high-pressure situation. Take time to review and re-evaluate the plan.

• Seek legal advice or consult relevant statutes if you are unsure what constitutes a pyramid or Ponzi scheme.

Q. Are they illegal?

A. Under the federal Competition Act, there are serious criminal charges that may be brought against anyone operating or affiliated with a Ponzi or pyramid scheme.